No Detroit-style collapse here, but there are infrastructure needs: CIBCCanadians need not fear a Detroit-style bankruptcy, CIBC says, but should be concerned about the need for infrastructure.

A lone vacant graffiti covered house sits in an area that used to be filled with houses in Detroit's east end on March 20, 2013. Over years of decline, many homeowners have lost their homes and they have been torn down if they become uninhabitable.
The Globe and Mail

Data

A for sale sign is seen on the lawn of a Toronto home. The Canadian Real Estate Association says home sales were down in June from year-earlier levels, but higher compared with the previous month.
The Globe and Mail

REAL ESTATE

The historic Detroit meltdown does beg the question of whether such a municipal bankruptcy could occur in Canada, CIBC World Markets economist Warren Lovely says.

But it’s highly unlikely.

“If Detroit isn’t a harbinger of wide scale U.S. municipal defaults – and it doesn’t appear to be – it’s even less the proverbial canary in the coal mine for Canadian municipalities,” Mr. Lovely said in a report today.

Debt burdens among Canadian cities are sustainable, and “limited net new bond supply should see municipal credit spreads continue to trade at the tight end of the range observed in recent years,” he added.

The issues are different, as well. At the heart of the Detroit collapse was the exodus from the city, whose population plunged to about 700,000 from 1.8 million in the 1950s. And the city’s debt hit junk status several years ago.

In Canada, cities are growing, and their credit ratings are sound.

Most of the about 50 municipalities that are rated boast double-A ratings or better.

“Notwithstanding some isolated actions, the average credit rating of Canada’s large municipal issuers is actually stronger today than it was before the global financial crisis,” said Mr. Lovely.

That doesn’t mean there aren’t issues, only that they’re different, particularly in the need for infrastructure.

“Despite extraordinary fiscal stimulus in the wake of the global recession, Canadian cities still face meaningful capital spending pressures,” Mr. Lovely said in his report.

“In Eastern and Central Canada, these needs often relate to the replacement of aging infrastructure. In Western Canada, many cities are rushing to put in place the roads, sewers and other vital capital required to support a burgeoning population and rapidly growing industrial base. Public transit needs are particularly pressing in the largest urban centres.”

Should Bank of Canada eye jobless rate?All of which begs the question: Should the Bank of Canada also target unemployment as well as inflation?

Canada’s central bank now links its benchmark rate to a target for annual inflation of 2 per cent, the mid-point between a band of 1 per cent and 3 per cent.

Canada is different than the United States and Britain, of course, having regained all the jobs lost to the crippling recession.

Having said that, Canada’s jobless rate remains stubbornly above 7 per cent, and is expected to remain in that area through at least next year.

While some observers say employment should be part of the central bank’s mandate, others don’t think so. And, notes CIBC World Markets, it does it anyway in practice.

“The bank targets only inflation, but the main driver of its inflation forecast is the output gap, the degree of slack in the economy,” said CIBC’s chief economist, Avery Shenfeld.

“While that measure of slack is based on GDP, you could also track it by looking at unemployment,” he added.

“At the end of the day, the Bank of Canada tends to project soft inflation when unemployment is high, and accelerating inflation when unemployment is low, so it nearly always behaves as if the jobless rate was also a target.”

The other difference, of course, is that both the Federal Reserve and the Bank of England are at this point using other forms of stimulus, as well, while the Canadian central bank is not.

“The advantage of tying future monetary policy decisions to the unemployment rate is that it can provide extra stimulus at a time when rates are already very low,” said deputy chief economist Derek Burleton of Toronto-Dominion Bank.

“By offering a more clearly articulated path on conditions for eventual unwinding of stimulus, bond investors feel more confident, and bond yields drop,” he added.

“However, the potential cost is a loss of central bank credibility. “Making explicit targets on changes in policy stance can box a central bank in if economic conditions unfold differently than expected. Communicating changes would be a major challenge in that event.”

In Canada, said Mr. Burleton, the potential costs seem to outweigh the benefits.

“The Canadian economy is operating at a higher level than that of the U.S. and U.K. Additional stimulus does not appear to be warranted.”

“Do not underestimate how wireless markets can be disrupted: Wireless financials can be significantly compromised by regulatory shifts and successful new entrants,” analyst Colin Moore of Credit Suisse said today.

“For example, in 2012 Iliad launched a fourth network in France and has gained 10 per cent share of subscribers through disruptive pricing,” Mr. Moore said in a report, referring to Verizon by its stock symbol, VZ.

“While Canadian carriers have lost $5-billion in market cap since the VZ threat emerged in June, the combined French telecom market cap has dropped by almost €35-billion since Iliad gained spectrum in 2009.”

Mr. Moore looked at 34 OECD countries, and found just 30 per cent have four players or more, and their population densities are generally greater.

“Far more developed markets are consolidating rather than expanding,” he said, noting that “very few” fourth carriers in a given country that have set up shop in the past 10 years have won a market share of more than 10 per cent to 15 per cent.

And they’re still not hugely profitable.

“Ironically, the market disruption caused by new entrants often leads to consolidation, although that may not be a regulatory option in Canada,” Mr. Moore said.

“The message is that a new entrant, particularly a committed one, can become a destabilizing agent for a long time,” he added in his report, titled “Three’s a crowd; four’s a feud: Global lessons from four carrier wireless markets.”

Canada is ruled by three major players, with a handful of upstarts. One of them, Wind Mobile Canada, has run into trouble, and Verizon is interested in it, going to so far as to table an initial $700-million bid earlier in the year.

As The Globe and Mail’s Rita Trichur reports today, Wind boosted its subscriber base to more than 620,000 in the second quarter, but its foreign financial backers continue to consider a sale.

“Our research indicates that a committed challenger could cause significant financial disruption to incumbents,” Mr. Moore said today.

“Not all new entrants are successful, but VZ would have the tools: New competitors have high hurdles and are not always successful, even with existing infrastructure and low-cost operations,” he added.

“The risk with VZ committing to Canada is that it would have the financial power and patience to invest in a stronger network, but even leveraging its U.S. asset, would likely still need reasonable subscriber share to gain scale.”

Investors, he said, are now pricing in a “moderate VZ entry scenario,” but a full-scale commitment by the U.S. giant “would likely lead to further pressure and cause a long-term overhang on the sector.”

Fact and fiction
Bank of Nova Scotia this week weighed in with a new report that looks at the
myths and facts surrounding the Verizon issue and the Canadian regulator’s new
wireless code of conduct. Here’s what analyst Jeff Fann says, referring to
Verizon Wireless as VZW:

Myth: Verizon’s entry would bring cheaper prices.

Fact: “VZW’s prices in the United States for data share
plans are on par to 10 per cent more expensive than the new equivalent Canadian
two-year shareable data plans … If VZ/VZW starts to gain meaningful subscriber
share and one of the three Canadian incumbents decides to react by reducing
prices to maintain share, perhaps that would help bring lower prices over time.
However, this will likely take time and will not be the initial impact of VZ
entering the market.”

Myth: Canadian regulators are succeeding in their quest for
lower prices, more choice.

Fact: “By introducing the Wireless Code, the CRTC has caused carriers to raise
monthly smartphone prices by 9%-19% over the past few weeks … and have caused
the carriers to remove the three-year contract option. That’s right, while consumers are now free from
three-year contracts they have to pay a higher monthly price to receive this
so-called ‘benefit.’ Furthermore, there are fewer choices for consumers.”

Myth: The government wants four carriers in each region.

Fact: “The ‘old’ fourth operators are not going to get any
help from Industry Canada. In the provinces of Quebec, Atlantic Canada,
Manitoba, and Saskatchewan, the current fourth operators are being
disadvantaged by the current policies if VZ/VZW decides to enter these regions.”

Fact: “Even VZ does not believe the current Canadian
wireless policy will bring sustainable competition … VZ is behind a report that
suggests that preferential and discriminatory Canadian auction rules will not
sustain long-term competition and some form of consolidation is inevitable in
the future.”

BHP still keen on SaskatchewanBHP Billiton’s new chief executive officer is still keen on the mining giant’s proposed $14-billion Jansen project in Saskatchewan despite the turmoil in the global potash market.

“We think very long term,” Andrew Mackenzie told reporters in Melbourne today, according to the Reuters news agency.

“This is something that’s happened short term … We’ve always said that potash is a business which will lose some of its cartel-like structure and become in time globally traded like everything else, so we, to some extent, predicted what’s happened.”

What’s happened was a dramatic shakeup in the world of potash, with the collapse last week of a Russian cartel that sparked projections of a drop in global prices of $100 (U.S.) a tonne and hammered the shares of global producers such as Potash Corp. of Saskatchewan, Agrium Inc. and The Mosaic Co.

Analysts are now questioning whether BHP will proceed with the Jansen mine as potash prices are forecast to drop to the $300-a-tonne range from the current $400.

That’s because Russia’s Uralkali pulled out of its cartel last week, saying it would chase volume rather than price. That puts pricing pressure on the North American cartel, Canpotex, which is made up of Potash Corp., Agrium and Mosaic.

In a research report yesterday, BMO Nesbitt Burns analyst Tony Robson said the potential now for marked change in the market could well prompt BHP to rethink its strategy.

“BMO Research sees BHP’s best way forward is simply to put Jansen on permanent deferral, until the supply-demand price equation becomes clearer, and return to cash to shareholders,” he said.

Airline narrows lossAir Canada’s loss narrowed in the second quarter of the year to $23-million or 9 cents a share, from $161-million or 59 cents a year earlier.

But on an adjusted basis, which excludes various factors, earnings climbed to $115-million or 41 cents from a loss of $7-million or 2 cents, The Globe and Mail’s Guy Dixon reports.

“Looking ahead, our focus remains on the execution of the corporation’s business plan led by our four core priorities: cost transformation, international growth, customer engagement and culture change to transform Air Canada into a sustainably profitable company for its shareholders and employees,” said chief executive officer Calin Rovinescu.

Building permits fallCanada’s home building industry marked a bit of a setback in June as construction permits declined for the first time in six months.

But, Statistics Canada said, the drop of 10.3 per cent from May was largely because of developments in non-residential construction in Quebec and the residential sector in Ontario.

On the residential side of things, building permits for multiple units, such as condos and apartments, fell 18.8 per cent. For single-family homes, permits fell 7.4 per cent.

The overall showing said economist Peter Buchanan of CIBC World Markets, suggests that “housing starts may begin to slow in coming months from levels which continue to appreciably outpace underlying family formation.”

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